Funding Your Company: Debt versus Equity

One of the greatest challenges facing businesses today is securing financing, whether to fund current operations or to expand them. When you look for funding, your choices are debt financing – where you borrow money, or equity financing – where you look for someone to invest in your company. Each option has significant plusses and minuses:

Advantages of debt versus equity

When you borrow money, the lender doesn’t have a claim on your business’ equity, so borrowing money doesn’t dilute your ownership interest in your business.

Your business relationship with the lender ends when you pay back the loan, while your relationship with an investor may last as long as your business does.

You generally know exactly what your loan payments are, so you can easily budget for that expense.

You can deduct the interest, which effectively reduces the cost of the loan.

The lender only gets the return of the agreed upon principal and interest and is not entitled to any portion of your future profits.

With a loan, you don’t have obligations to provide regular reports to investors, to hold meetings with them, or to secure their votes before acting.

You don’t have additional owners who want your time and attention, and who may offer unwanted “help.”

Disadvantages of debt compared to equity

You may not meet the criteria required for a loan from a bank or other lender. (Credit scores are one of the biggest factors in getting – or not getting – loans today, so make sure your credit score is adequate before applying for a loan.)

Loans must be repaid, usually on a fixed schedule. (Equity investors, however, may be entitled to a percentage of your profits.)

Interest on the loan is an additional expense you have to cover, and you’re spending your money on interest payments that you could instead be investing in your business.

Loans often impose restrictions on some of your activities, such as securing additional financing.

You will probably have to pledge some of your company’s assets to serve as collateral for the loan. And, you may have to personally guarantee the loan and possibly pledge some of your personal assets.

In a future column, we’ll look at the various sources of debt financing.

Dave Archer is President / CEO of member-supported NCET.org, which produces business and technology events to help small businesses and entrepreneurs. (www.NCET.org)

About Dave Archer

Dave Archer is President and CEO of NCET, which produces business and technology events to help Nevada’s entrepreneurs and small businesses. More info at www.NCET.org.